What this lesson teaches
I can work out how shifts in demand or supply change price, quantity, spending, revenue, consumer surplus and producer surplus.
Syllabus 9570, 2.1.2(f). Demand and Supply Analysis and its Applications: Changes in demand and supply can affect equilibrium price and quantity, consumer expenditure, producer revenue, consumer surplus and producer surplus
Make a guess
A cafe cuts the price of a drink from $6 to $5, and sales rise from 80 to 110 a day. Does its revenue rise or fall?
- It falls, because each drink now earns $1 less.
- It stays the same, because the two changes cancel out.
- It rises, from $480 to $550.
- It falls, because cutting prices always cuts profit.
Show the answer
It rises, from $480 to $550.
Revenue is price times quantity. The rise in drinks sold is proportionally bigger than the price cut, so revenue rises.
Spending and revenue both equal price times quantity sold.
Consumer expenditure is what buyers spend: price times quantity bought. Producer revenue is what sellers receive: price times quantity sold. Without a tax or subsidy, they are the same amount.
On a diagram, total revenue is the rectangle under the equilibrium point: price P0 times quantity Q0.
When price and quantity move in the same direction, revenue moves that way too. When they move in opposite directions, revenue could rise or fall, so calculate it. The next chapter shows how price elasticity of demand predicts the answer.
Revenue is not profit. Profit is revenue minus costs.
- Revenue
- Price x quantity sold.
- Same direction
- If P and Q both rise, revenue rises.
- Not profit
- Profit = revenue - costs.
Worked example: A lower price and more sales
A cafe sells 80 drinks a day at $6. After supply increases, it sells 110 a day at $5.
- Before: 80 x $6 = $480 a day.
- After: 110 x $5 = $550 a day.
- Price fell but quantity rose by proportionally more, so revenue rose by $70.
- We cannot say what happened to profit without knowing the cafe's costs.
Watch out for this
A higher price always gives the seller more revenue and more profit.
A higher price can reduce the quantity sold enough to cut revenue. Profit also depends on costs.
Check your understanding
A shop sells 50 notebooks a week at $4, then 70 a week at $3. What happened to revenue?
- It rose from $200 to $210.
- It fell, because the price fell.
- Profit rose by $10.
Show the answer
It rose from $200 to $210.
Right. 50 x $4 = $200 and 70 x $3 = $210. Quantity rose proportionally more than price fell.